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The China Investment Challenge

A bank clerk counts a stack of US dollars together with stacks of 100 yuan notes at a bank in Huaibei, China on May 20, 2010. (AFP/AFP/Getty Images)

A bank clerk counts a stack of US dollars together with stacks of 100 yuan notes at a bank in Huaibei, China on May 20, 2010. (AFP/AFP/Getty Images)

By Orville Schell

Originally published by Project Syndicate on Aug. 23, 2010

NEW YORK – China now sits atop $2.4 trillion in foreign-exchange reserves, the largest stockpile of any country in the world (Japan stands in second place with $1 trillion). But this bounty comes with one big headache: where should Chinese Communist Party officials park all that money?

International bankers estimate that roughly two-thirds of Chinese reserves have been invested in dollar assets. In other words, China owns a huge chunk of America’s ballooning debt. Chinese reserves invested in these conservative financial instruments are relatively safe, but they yield little return. They have, however, helped support China’s economy by allowing Americans to run up consumer debt by buying more Chinese goods than they rightfully need.

A moment of truth is looming for both sides of this co-dependent, and ultimately dysfunctional, economic relationship. First, there are limits to how many trillions of dollars China can, and should, put into US Treasury bills. After all, should the dollar depreciate, China does not want to have too many eggs in the US basket. Investors should diversify their risk, and so must China.

But with so much capital, the options are limited. Until the euro weakened recently, Chinese bankers had been buying more euro-denominated assets, no doubt recognizing that, despite the frailty of the eurozone economy, Chinese exporters also need European consumers to keep buying their goods. But the reality is that neither the euro nor the yen is capable of soaking up China’s growing foreign-exchange reserves.

It is hardly surprising, then, that Chinese officials have begun to seek more diverse and profitable investment possibilities worldwide. While we have become familiar with China’s ardent interest in natural resources such as oil, coal, steel, copper, and soybeans, we are far less acquainted with other kinds of Chinese investments, including outright acquisitions of foreign companies.

Here the US has not yet shown itself to be a particularly hospitable environment for Chinese investments. This has been especially true when Chinese state-owned enterprises (SOEs) have aspired to buy, or buy into, iconic US corporations that have a blush of national-security significance about them.

Things got off to a poor start in 2005, when the China National Off-Shore Oil Corporation (CNOOC) tried to buy Unocal. Even though almost all of the oil produced by Unocal would have ended up on world markets rather than back in China, the US Congress’s skittishness assured that Unocal was sold to homegrown Chevron.

Although Chinese investors have since made numerous lower-visibility plays in US markets, the failed Unocal deal left a legacy of bitterness. So it is hardly surprising that gun-shy (and miffed) Chinese investors are wary about making further major efforts in the US. Huawei’s recent failed bids for 2Wire and Motorola will only have rekindled this bitterness.

Indeed, a case similar to Unocal arose this summer. The Anshan Iron and Steel Group, a Chinese SOE, tried to buy a 20% interest in the Mississippi-based Steel Development in the hope of setting up a re-bar plant in the US. News of the pending deal caused 50 Congressional Representatives from the US steel caucus to write a letter to Treasury Secretary Timothy Geithner calling for an investigation of the threat the deal posed to US national security and American jobs.

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